Skill Level Beginner
- Enron declared bankruptcy in December 2001 amid accusations of accounting fraud. Congressional consideration of the need for enhanced regulation of the accounting industry was given an additional jolt when WorldCom, which was subsequently purchased by Verizon, announced its accounting-related bankruptcy in July of 2002. In short order, the US Congress passed the Sarbanes-Oxley Act of 2002. This act is often referred to by those in accounting and the finance world as SOX.
It is also referred to by other names, but we're not going to go there. To accountants, the Sarbanes-Oxley Act includes a host of interesting provisions. the creation of the PCAOB, that's the Public Company Accounting Oversight Board. New funding arrangements for the FASB. Revised rules on auditor-client relationships and a new requirement that a company's CEO and CFO personally vouch for the fairness and reliability of the financial statements. But the section of Sarbanes-Oxley that has the biggest impact is Section 404 on internal controls.
In fact, you may have heard of this term within your company, a SOX audit. What this means is an audit of the internal controls of the company. Section 404 of Sarbanes-Oxley instructs the SCC to require all publicly traded companies to provide a report on the condition of the company's internal controls over the financial reporting process. These financial reporting controls include company procedures to ensure that all transactions are recorded so that the public financial statements are not rendered irrelevant by secret side agreements.
Proper internal controls also include procedures to ensure that no transaction takes place unless it's approved by proper authority. In addition, a good internal control system establishes procedures to safeguard the value of the company's assets. Now conceptually, the Section 404 requirement to increase the scrutiny of internal controls is admirable and expected in the wake of the accounting scandals where internal controls obviously were lax. However, as companies began to implement Section 404, a low murmur of grumbling started to emerge.
At the time of implementation, publicly traded companies estimated that their audit fees increased up to 25%, primarily because of the increased audit work needed to verify compliance with Section 404. In addition to the increased cost of their public auditors, companies had to incur significant cost within their companies to implement new internal controls. Again, internal controls are a good thing, but they come at a cost. It takes time and it takes money to ensure that internal controls are being effectively implemented.
And from a distance, these internal controls can appear like busywork, created to make our job more difficult. A lot of times, we look at this red tape and paperwork as a nuisance that someone cooked up to make things harder for us. But if you step back and take a broader view, at the bottom of a lot of that red tape and paperwork is an effort to protect the financial assets of a company, the reputation of the company, and the employees of the company, that means you. The biggest benefit of these internal controls is that nothing goes wrong.
The rules are followed, the procedures are followed, and all goes well. And then we can start to think things are going well. Why do I need this red tape and this paperwork? Well, if you stop and think about it, it may just be that the red tape and paperwork is why things are going well. In fact, the biggest expected benefit of this emphasis on internal controls is something that can't be observed at all, the absence of problems that would have occurred without the internal controls that were mandated by SOX.
Q: Why can't I earn a Certificate of Completion for this course?
A: We publish a new tutorial or tutorials for this course on a regular basis. We are unable to offer a Certificate of Completion because it is an ever-evolving course that is not designed to be completed. Check back often for new movies.